Rethinking the startup economy
Business Standard, 22 August 2022
The excitement in the Indian startup world is overstated. Building a genuine business is hard, and the few get-big-quick stories have had an exaggerated impact upon the imagination. The US Fed started tightening from February 2022, and this has impacted risky and illiquid assets worldwide. Exchange traded equities -- worldwide and in India -- have been more discerning in judging these firms.
There is a lot of optimism about startups. We should not overstate their role. The Indian workforce is about 400 million people. There are perhaps 10,000 startups with an average of 50 employees each giving 0.5 million employed. Alternatively, broad market value is about Rs.267 trillion. Each 100 firms at a market value of $1 bln add up to a market capitalisation of Rs.8 trillion. These magnitudes -- Rs.267 trillion vs. Rs.8 trillion, and 400M workers vs. 0.5M workers -- help us stay grounded.
The fascination is more a human interest phenomenon. Each individual in the world of business looks to maximise wealth, and is inundated by messages about the twenty-something billioniares. There is a psychological problem here which is similar to that seen with social media: everyone else seems to be having a better life. The handful of individuals who made it past a billion dollars in their twenties are lionised, while the poor outcomes for the remaining 10,000 firms remain in the shadows.
At its peak, the hype around the startup world was inducing difficulties in the economy. Anecdotes abound from the labour force doing IT product development, where the size of the startup economy is material compared with the overall economy. This workforce is disproportionately young, and many young people drifted from one startup to another, hoping to hit the jackpot. Alternatively, young people from famous universities have exploited the credentialism of investors, and made money for a few years, but this comes at the cost of the learning that comes from complex organisations and mentors. These problems have hampered IT product development in India, which faced a peculiarly footloose and low-skill workforce. It was also bad for the knowledge development of many individuals, who lost out on the possibility of building capability by digging into one problem for many years and from learning opportunities.
Some in the leadership teams of mature firms lost their nerve, wondering whether they should be in the get-big-quick game rather than the slow process of building organisations. To this extent, the hype around the startup world has detracted from the resourcing and sustained attention for the marathon-running that goes into building organisations.
The Indian VC and PE industries got to great success with many an IPO. But the world of listed equities has been more discerning. The public market features millions of traders, and it is harder to fly on fumes here. Many richly priced IPOs have fared badly after the listing date. This has, in turn, made it harder to others to achieve exuberant listings. This is feeding back into the funding environment at earlier stages.
Alongside this, financing conditions worldwide have changed. From early 2022, rates started going up in developed markets. Developed market tightening triggers a retreat of global capital from illiquid and risky assets worldwide, in favour of well understood developed market assets such as government bonds and index funds. This triggered off turmoil in many exotic assets, ranging from cryptocurrency to startups.
Some famous firms in the West have led the way with poor performance. Theranos had a valuation of $9 bln in 2015 and has closed with the founder in jail. WeWork peaked at $47 bln in 2019 and dropped to $3 bln in a year. Klarna peaked at $45 bln in 2021 and stood at $7 bln last month. Similar problems have unfolded for some famous firms in India. There are similarities between the startup scene worldwide and in India, through commonalities of human psychology and the shared exposure to DM monetary tightening.
The hype around the startup world was inducing difficulties in the economy. Conversely, the present difficulties are bringing about greater common sense. Startups will be less jittery and hype-driven: they will worry more about the burn rate, buy inputs in a more sane way, and focus more on actually building a business. The IPO market will be more discerning, preferring firms that have organisational capability. The IT product development labour market will become more sensible. There will be fewer got-rich-quick stories in the press. This will improve the focus of the leadership of large firms upon their basic task, of running the marathon of building organisational capability in large complex firms. New kinds of strategic thinking are required in finance, on sensible levels of risk and reward, on the appropriate role for startups, venture funding, PE, IPOs, family offices, and established business groups.
Ultimately, two analogies are at the heart of the optimism. Are the startups of today analogous to Google and Netflix in the US: innovators who transformed the world and profited enormously? We in India are mostly doing more trivial things like delivering food, and the upside of scaling is limited by the Indian institutional environment, by the policy risk and limited rule of law.
Are the startups of today analogous to TCS and Infosys: firms that were once offbeat and unusual in the eyes of the old economy, but now command a market capitalisation of Rs.12 trn and Rs.7 trn, firms that laid the foundation for IT to become India's biggest industry? First, neither is a get-big-quick story: TCS began in 1968 and Infosys in 1981. It was a journey of careful organisation building, unlike the behaviour of many young firms today. Second, there was a business model at the foundation of these firms -- to hire Indian talent and serve the world -- which made immense sense, which has an essentially infinite upside.
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